i
An alternative approach to the integration of
the informal sector into the South African
tax base
MD Kgatla
23983388
Mini-dissertation submitted in partial fulfilment of the
requirements for the degree Magister Commercii in
South
African and International Taxation
at the Potchefstroom Campus
of the North-West University
Supervisor:
Mrs CE Meiring
i ABSTRACT
TITLE: AN ALTERNATIVE APPROACH TO THE INTEGRATION OF THE INFORMAL SECTOR INTO THE SOUTH AFRICAN TAX BASE
Small businesses in the formal sector emerge from the informal sector. These small businesses play an important role in the economy. The informal sector creates job opportunities for the unemployed and for those who seek entrepreneurship opportunities with limited capital resources.
The South African Revenue Service (SARS) constantly faces a challenge of growing the tax base in order to increase tax revenues from one tax period to the next. There are a number of factors that affect the maintenance and growth of the tax base, one of which is base erosion and profit shifting.
This study discusses the unique characteristics of the informal sector small, micro and medium enterprises (SMMEs) and the nature of their operations. This provides an understanding of the SMMEs in this sector and explores some of the challenges that these informal sectors businesses face in their operations.
The study further discusses whether the current income tax relief initiatives can cater for the uniqueness of the informal sector SMMEs. The study discusses their objectives, practicality in applications and the challenges that could arise in applying them to encourage registration by informal sector SMMEs.
In order to be able to incorporate the informal sector business into the tax base, SARS would need a mechanism or program that allows for the identification of the informal sector business. As a result this study considers a Block Management System that was implemented by Tanzania in 2005 which was developed in order to cater for the unique characteristics of informal sector businesses. The Block Management System’s objective is to focus on the physical identification and mapping of taxpayers.
Conclusions drawn from this study are that SARS has realised the importance of small businesses in the economy and has put several initiatives in place for small businesses but currently these provisions do not serve as an incentive for the informal economy small businesses to register and pay taxes. It was found that SARS would benefit from the implementation of a similar program to the Tanzania Block Management System as it will assist with the identification of informal sector businesses to integrate it into the South African tax base.
ii KEYWORDS
Informal Sector
Informal Economy
Informal trading
Tanzania Block Management System
iii TABLE 1: LIST OF ABBREVIATIONS
Abbreviation Description
CGT Capital Gains Tax
CIPC Companies and Intellectual Property Commission
CIT Corporate Income Tax
DHA Department of Home Affairs
DTI Department of Trade and Industry
Eighth Schedule Eighth Schedule of the Income Tax Act No. 58 of 1962
GDP Gross Domestic Product
Income Tax Act Income Tax Act No.58 of 1962
OECD Organisation for Economic Cooperation and Development
PAYE Pay As You Earn
PIT Personal Income Tax
SARS South African Revenue Service
SBC Small Business Corporation
Sixth Schedule Sixth Schedule of the Income Tax Act No.58 of 1962 SMEs Small and medium enterprises
SMMEs Small, micro and medium enterprises TAA Tax Administration Act No.28 of 2011 TCC Tax Clearance Certificate
TRA Tanzania Revenue Authority
TZS Tanzanian Shillings
VAT Act Value-Added Tax Act No.89 of 1991
VAT Value-added tax
iv
TABLE OF CONTENTS
TABLE 1: LIST OF ABBREVIATIONS ... iii
1.1
INTRODUCTION ... 1
1.2
BACKGROUND TO THE RESEARCH AREA ... 4
1.3
MOTIVATION OF ACTUALITY OF RESEARCH TOPIC ... 5
1.4
PROBLEM STATEMENT ... 8
1.5
RESEARCH OBJECTIVES ... 9
1.6
RESEARCH METHOD ... 10
1.7
CHAPTER DIVISION ... 12
1.7.1.
Chapter 1: Introduction and background ... 12
1.7.2.
Chapter 2: Informal sector, historical overview and literature review ... 12
1.7.3.
Chapter 3: Tax relief initiatives applied in South Africa for small
businesses ... 13
1.7.4.
Chapter 4: Tanzania Block Management System ... 13
1.7.5.
Chapter 5: Conclusions and recommendations ... 14
2.1.
INTRODUCTION ... 15
2.2.
THE ORIGINS OF THE TERM ‘INFORMAL SECTOR’ ... 15
2.3.
INFORMAL SECTOR DEFINED ... 16
2.4.
DISTINGUISHING CHARACTERISTICS OF THE INFORMAL SECTOR ... 22
2.5.
MEASURING THE SIZE OF THE INFORMAL SECTOR ... 24
v
2.5.2.
INDIRECT/INDICATOR METHODS ... 25
2.6.
THE ROLE OF THE INFORMAL SECTOR IN SOUTH AFRICA ... 28
2.7.
CHALLENGES FACING SMALL BUSINESS IN SOUTH AFRICA ... 31
2.8.
CONCLUSION ... 34
3.1
INTRODUCTION ... 37
3.2
‘SMALL BUSINESS’ DEFINITION FROM A SOUTH AFRICAN TAXATION
PERSPECTIVE ... 38
3.2.1.
Definition in relation to Income Tax ... 38
3.2.2.
Definition in relation to capital gains tax ... 39
3.2.3.
Definition in relation to turnover tax for micro businesses ... 40
3.3
SMALL BUSINESS TAX-RELIEF INITIATIVES ... 41
3.3.1.
INTRODUCTION ... 41
3.3.2.
SMALL BUSINESS CORPORATIONS: REDUCED PROGRESSIVE TAX
RELIEF INITIATIVE ... 41
3.3.2.1.
Description of the reduced progressive tax-rate initiative ... 41
3.3.2.2.
Objective of the reduced tax rate-relief initiative ... 42
3.3.2.3.
Challenges of the reduced progressive tax-rate relief initiative in the
informal sector ... 42
3.3.3.
SMALL BUSINESS CORPORATION: ACCELERATED DEPRECIATION
TAX-RELIEF INITIATIVE ... 43
3.3.3.1.
Description of the accelerated depreciation tax-relief initiative ... 43
vi
3.3.3.3.
Challenges of the accelerated-depreciation tax-relief initiative in the
informal sector ... 44
3.3.4.
CAPITAL GAINS TAX: PAR 57 OF EIGHTH SCHEDULE ‘DISREGARD
SMALL BUSINESS CAPITAL GAINS TAX’ RELIEF INITIATIVE ... 45
3.3.4.1.
Description of the ‘disregard small business capital gains tax’ relief
initiative 45
3.3.4.2.
Objectives of the ‘disregard small business capital-gains’ tax-relief
initiative 47
3.3.4.3.
Challenges of the ‘disregard small-business capital-gains’ tax-relief
initiative in the informal sector ... 47
3.3.5.
SIXTH SCHEDULE TURNOVER TAX FOR MICRO BUSINESS TAX-RELIEF
INITIATIVE ... 48
3.3.5.1.
Description of the ‘micro business turnover tax-relief’ initiative ... 48
3.3.5.2.
Objective of the ‘micro business turnover-tax’ relief initiative ... 49
3.3.5.3.
Challenges of ‘micro business turnover-tax relief’ initiative in the
informal sector ... 50
3.4.
CONCLUSION ... 51
4.1
INTRODUCTION AND BACKGROUND ... 54
4.2
TANZANIA REVENUE AUTHORITY ... 54
4.3
TANZANIA SMEs AND THE INFORMAL SECTOR ... 55
4.4
INFORMATION GATHERING POWERS OF TRA ... 56
4.5
CHALLENGES OF TAXING SMEs IN THE INFORMAL SECTOR ... 57
vii
4.6.1.
Structure of the Block Management System ... 60
4.6.2.
Block Administration ... 61
4.6.3.
Outcomes and benefits of the project ... 61
4.7
CONCLUSION ... 62
5.1
CONCLUSIONS AND RECOMMENDATIONS ... 64
1 CHAPTER 1
INTRODUCTION AND BACKGROUND
1.1
INTRODUCTIONThe levying of taxes is imperative for a government to ensure that it achieves its economic objectives which, amongst others, include the economic development of the country and regulating the levels of employment (Croome, 2010). In terms of Sections 3 and 4 of the South African Revenue Service Act (34 of 1997), the South African Revenue Service (SARS) is empowered to administer and collect taxes in South Africa.
In South Africa, income tax is levied in terms of the Income Tax Act (58 of 1962) (Income Tax Act). The Income Tax Act does not define tax base, the Income Tax Act however does define a term referred to as taxable income.
Taxable Income is defined in the Income Tax Act as:
“the aggregate of amounts remaining after deducting from the income (gross income and deemed income) of any person:
all the amounts allowed as valid qualifying deductions of expenditure and losses incurred in the production of income from carrying on a trade; and
all exempt receipts and accruals in terms of Section 10 of the Income Tax Act.”
Taxable income is therefore the amount to which the applicable tax rate would be applied in determining the tax liability of a registered taxpayer. The International Labour Relations (2003) defines a taxable base as an amount or thing to which the tax rate is applied. The tax base can be defined as those activities of the taxpayer that generate revenue in the form of income and growth in assets, which after taking into account any deductions and exemptions given by SARS will be subject to taxation.
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The amounts to which a rate of tax is applicable (in order to determine the tax liability of a taxpayer) will therefore be based on each of the provisions in each of the Acts SARS administers.
South Africa has a residence-based income tax system. The effect of the residence-based income tax system is that a resident’s worldwide taxable income is subject to income tax in South Africa. And for non-residents, taxable income from sources within South Africa are subject to tax within South Africa (SARS, 2014).
The Income Tax Act is an example of legislation relating to income tax, turnover tax on micro businesses, capital gains tax, withholding tax on foreign entertainers and sportspersons, withholding tax on payments to non-residents on the sale of their immovable property in South Africa, donations tax and dividends tax (SARS, 2014). Each has specific rules and provisions of how to determine the taxable income or tax base to which the applicable tax rate will be applied in order to determine the tax liability.
In his 2014 Budget Speech, the Finance Minister at the time, Pravin Gordhan, declared that central to the National Development Plan (NDP) is the commitment to a social pact to reduce poverty and inequality, and to raise employment and investment (National Treasury, 2014:9).
The economic objectives of a country, such as economic development, the reduction of poverty and the creation of employment, require adequate funding to enable the government to achieve these objectives. It is therefore important for any government to have and maintain a sustainable flow of national tax revenue, as this will ensure that the services and deliverables (e.g. infrastructure investments, social spend, etc.) by the government are properly implemented (OECD, 2013; Meena, 2013).
The Organisation of Economic Co-operation and Development (OECD) defines tax revenue as revenues collected from taxes on income and profits, social security contributions, taxes levied on goods and services, payroll taxes, taxes on the ownership and transfer of property, and other taxes (OECD, 2015).
The Minister of Finance, Pravin Gordhan, stated that there is a part to be played by all South Africans (National Treasury, 2014:32). Both the formal and informal sectors of the economy contribute to revenue for national development (Oberholzer and Smulders, 2006:8).
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It is important to consider the contribution of the informal sector. The informal sector firstly needs to be properly defined to understand what it entails - but according to Naidoo (2002) (cited by Ligthelm, 2004b), no single definition exists to define the informal sector.
In January 1993, the 15th International Conference of Labour Statisticians (15th ICLS) adopted
an international statistical definition of the informal sector that was subsequently included in the revised International System of National Account (ILO, 1993). According to the ILO (1993), the informal sector may be defined as consisting of units engaged in the production of goods and services with the primary intention of generating employment and income. These units operate at low levels of organisation. Labour relations, where they exist, are based on casual employment, and personal and social relations, rather than contractual arrangement with formal guarantees (ILO, 1993).
The 15th ICLS (ILO, 1993) characterised informal sector enterprises as:
Private, unincorporated enterprises that are owned by individuals or households and not constituted as separate legal entities from their owners.
At least some of the goods or services produced are meant for sale or barter.
The size of these enterprises, in terms of number of people employed, is below a certain threshold, and they are not registered in terms of national legislation.
The enterprises are engaged in agricultural activities, including secondary non-agricultural activities of enterprises in the non-agricultural sector.
According to the World Bank (2014), the informal sector is diverse and includes small-scale, occasional members (such as street vendors and garbage recyclers) as well as larger, regular enterprises.
According to the ILO (1993; 2003), as discussed above, the informal sector could be characterised by a low-scale production of goods and services with the objective of creating employment and income for the persons concerned.
The need to be employed is often the motivation for starting a business (Ligthelm, 2003). Although unregulated, the informal sector is not the same as the criminal or illegal economy; non-compliance in this sector is not to purposely avoid regulations and evade taxes. The motivational factor shows that it is made up of non-standard wage workers and entrepreneurs who produce legal goods and services, even though the way they do it is not regulated (Steyn, 2008). While there might be entrepreneurs who deliberately try to evade paying taxes, some
4
entrepreneurs are often either not aware of the regulations or they cannot afford to comply with regulations (Steyn, 2008).
1.2
BACKGROUND TO THE RESEARCH AREALarge multinational businesses have been believed to be the key to economic success. Since the beginning of the 1980’s, new and growing small firms were the ones creating most of the jobs (Ligthelm, 2003).
Kirchhoff indicated that many research studies on job-creation statistics have concluded that small to medium sized firms (those that employ fewer than 100 people) create most jobs. (Kirchhoff, 1995:19).
Since the 1980s, when studies have been done on the informal sector, several attempts have been made in measuring the informal sector (Blaauw, 2011).
The informal economy or sector accounted for roughly 7% of GDP in 1999 (Saunders, 2005);
Statistics South Africa estimated non-agricultural employment in the informal sector at 18.5% of the total employment in 2007 (Stat SA, 2007).
With such statistics, the informal sector could play an important part in providing jobs and reducing unemployment. The informal sector provides support to entrepreneurial activity and helps alleviate poverty (World Bank, 2014).
In his 2006 State of the Nation Address, the former president of the Republic of South Africa, Thabo Mbeki, emphasized the need for cooperation between large entities, government and development partners, to ensure that the benefit of economic growth filters down to the lower end of the informal sector (National Treasury, 2006).
While briefing the media on 25 October 2010, current President, Jacob Zuma, justified the Economic Growth Path Strategy as part of the response to the needs of SMMEs in South Africa (Zuma, 2010). This is an indication that, although it is seen as a sector which does not have rules and regulations (Steyn, 2008), the informal sector plays a significant/important role in South Africa.
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Jerven (cited by Ingle, 2013a) observes, appropriately, that the accurate reporting of GDP: “may be interpreted as an indicator of the power of a state. It expresses how much a state knows about itself, and this ability to know and to monitor is a direct measure of state power and may also be related to state legitimacy.”
1.3
MOTIVATION OF ACTUALITY OF RESEARCH TOPICAdcorp’s Employment Index (2014:1) indicated that the South African economy created 23,861 jobs during November and December 2013. Of this total, the informal sector alone added 12,722 jobs during this two-month period. For the period January to December 2013, the informal sector was recorded to have added 73,799 jobs, compared to the total decline of 241,536 in permanent and temporary jobs for the January to December 2013 period. These statistics reflect the growing importance of the informal sector in the South African labour market.
According to Statistics SA (2016), employment gains were realised for the formal sector for two quarters (quarter 2 and 4) of 2015, while the gains in the informal sector were realised during quarter 2 and 3 of 2015. In quarter 1 of 2016, both the formal and informal sectors experienced decreases in employment - with the formal sector showing a decrease of 217,000 and the informal sector a decrease of 111,000 jobs. This decrease, for both sectors, has been considered the largest since 2010.
Sharp (2014) stated that, with the growth experienced by the informal sector in South Africa, the informal sector is creating the much-needed jobs for the unemployed and unskilled - and alleviating poverty within many South African communities. Should the South African informal sector continue to grow and continue to play a greater and increasing part in the economy, the ideal would be for the government to become aware of this and become much more supportive of legitimate activities within the sector (Davids, 2011:3). The informal sector could play a key role in releasing the entrepreneurial spirit in South Africa (Ligthelm, 2003), and, as a result, create much-needed jobs and help to alleviate poverty in the country.
This study is pursued with the belief that knowing the dynamics of the sector may contribute towards an increased awareness of this important but unrecorded sector of the economy. This study aims to achieve an understanding into the informal sector and define the needs of this sector to comply with laws and regulations. By their nature, informal sector activities escape
6
regulation but that does not necessarily imply that they are unlawful or criminal (World Bank, 2015).
This study aims to identify the unique characteristic of the informal sector - and to determine how processes and procedures unique to this sector could be designed, to encourage voluntary compliance and allow government to monitor and measure the contribution of the informal sector.
Everyone needs to play a part in the development of the country (National Treasury, 2014:32), the informal sector could make a big difference in national tax revenues, and government may assist in the growth of this sector. With growth, some of these enterprises may move up into the formal economy.
Tanzania is one of the countries that faced a similar need to South Africa to expand and grow on their tax revenues. Tax administrators (the TRA) identified the importance of the formal and informal sector in the development of their country (Tanzania Revenue Authority, 2008:2,11).
The nature and structure of the Tanzanian economy is similar to that in South Africa – namely, a large informal sector, not well understood by tax authorities. Kimunyu and Kileva (2007) stated that the Tanzanian economy was characterised by small firms and very large micro enterprises. They categorised small and medium taxpayers based on their turnover. Small taxpayers earned on average between (Tanzanian Shilling) TZS0-39 million (that is, R0– R284 784) whereas medium taxpayers were those with a turnover between TZS40-9999 million (R284 784 – R71 188 938). Many of these small and medium taxpayers were noted to be operating in the informal sector (Kimunyu and Kileva, 2007).
The absence of systems and mechanisms in the Tanzania Revenue Authority (TRA) to reach a large number of taxpayers, as well as the limited knowledge about potential taxpayers in the informal economy, were identified as the challenges hindering the widening of the country’s tax base in order to attain and sustain a targeted tax-to-GDP ratio of at least 20% in 2010 (ADBG, 2010).
In their need to expand and grow tax revenues in Tanzania, the TRA embarked on a drive to ensure that all reachable taxpayers (both formal and informal) were identified, registered, and forced to pay tax.
7
The programmes implemented included (Kimunyu and Kileva, 2007):
Taxpayer education
The Block Management System
Presumptive Approach
Assessment procedures
Collection formalities and procedures
These programmes (as listed above) aimed to identify the potential taxpayer. Of greatest interest is the Block Management System (BMS).
The BMS was selected for this study, as it will assist in achieving the objectives of the research. In accordance with the view of Kimunyu and Kileva (2007), it addresses the integration of the informal sector, identifies possible new taxpayers, and attempts to encourage the culture of compliance across the formal and informal sectors.
The BMS is a system that was implemented by the TRA with the following aims (Kimunyu and Kileva, 2007):
To put in place sustainable methods and strategies to monitor business activities.
To monitor the activities of small and medium taxpayers, with a view to making them pay tax in a cost-effective way, thus reducing the compliance cost burden on these small to medium businesses.
The BMS system involved door-to-door surveys by TRA-appointed representatives. Each representative was allocated a demarcated geographical area/blocks. Each block was subjected to the full tax function of registering, assessing, collection and accounting for revenue (CMI, 2012). The representatives are responsible for updating the taxpayers’ personal and business information (Kimunyu and Kileva, 2007:19).
The introduction of the BMS was communicated to communities via seminars, radio and television programmes; outreach programmes to business places or trading centres; help desks and customer service points; and billboards, to name a few (Kimunyu and Kileva, 2007).
The main objective of the BMS is to have in place a sustainable method - and strategies - to monitor the business activities of small and medium taxpayers, with a view to making them pay tax in a cost-effective way (Tanzania Revenue Authority, 2008:9).
8
Between the 2010/2011 and 2012/2013 tax years, the number of SMEs in Tanzania grew from 372 600 to 493,714, and the revenue collected from these entities during this period increased from US$ 500m to US$ 900m (TRA, 2012).
Tanzania has been selected for the purposes of this study due to the nature of their informal sector, which operates under similar conditions as those in South Africa. With their economy characterised by small firms and very large micro enterprises, many of which operate in the informal sector, the TRA was faced with the challenges of the identifying and registering of enterprises as well as the non-compliance by these enterprises (Kimunyu and Kileva, 2007).
There have been challenges faced in the process of implementation, which have led to the formulation of further improvements to the system through constant monitoring and evaluation (African Tax Administration Forum, 2014).
Based on the literature review performed, it was found that the informal sector characteristics and challenges facing businesses in this sector, that were identified in South Africa are similar to those that exist in Tanzania as noted in par 2.4, 2.7, 4.3 and 4.5 of this dissertation (Bureau of Economic Research, 2016 and African Tax Administration Forum, 2014).
These unique characteristics of the informal sector have made it a challenge for the SARS and Tanzania Revenue Authority to tax the informal sector. TRA’s BMS program was implemented in Tanzania to address the challenges of identification and registration of informal SMMEs. This program/system could possibly assist South Africa in identifying and registering informal sector business and have them form part of the tax base.
1.4
PROBLEM STATEMENTThe informal sector is a growing economy that could contribute substantially to the revenue of South Africa. It is however a challenge to integrate the informal sector into the tax base, due to many constraints.
SARS has since 2001 made efforts to encourage the use of the SBC concept to encourage compliance of small business corporations by making use of certain incentives.
9
This study seeks to address this problem by answering the question whether the current tax relief initiatives for small businesses introduced in South Africa could be successfully applied in encouraging compliance in the informal sector to grow the South African tax base. Furthermore, the study seeks to determine if the Tanzania Revenue Authority Block Management System could be a possible alternative approach for South Africa to integrate the informal sector into the existing tax base.
1.5
RESEARCH OBJECTIVES1.5.1. Main Objective
The main objective of the research is to consider if existing South African legislation can encourage the growing informal sector into contributing to the national tax revenue, and to consider the Tanzania Block Management System as a possible approach for South Africa to adopt, to address this problem.
1.5.2. Secondary Objectives
To address the main research objective, the following secondary research objectives must be achieved:
i. To obtain an understanding of the nature and environment of the informal sector in South Africa, limited to only the tax implications. It is important to gain a comprehensive understanding of the informal sector and how it operates. This objective will be addressed in chapter 2.
ii. To evaluate the applicability of the current tax legislation and tax initiatives implemented by government in integrating the informal sector into the formal sector’s compliance culture. This chapter will review and evaluate the current provisions of the Income Tax Act, and assess whether the current tax legislation has been able to fully cater for the integration of the informal sector. Focus will be placed on the tax-relief initiatives implemented in the past few years for small businesses. This objective will be addressed in chapter 3.
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iii. To evaluate the Tanzania Block Management System to establish if a similar system could be adopted in South Africa that may assist South Africa in being able to integrate the informal sector into the formal sector. This objective will be addressed in chapter 4.
iv. To summarise and conclude on the findings of the previous chapter. This objective will be addressed in chapter 5.
1.6
RESEARCH METHODPrevious research has noted that informal sector entrepreneurs are very averse to talking to ‘unknown persons’ about their tax affairs, as most of the informal sector operators fail to discharge their tax obligations and they fear being discovered and made to face fines and penalties for non-compliance.
“Developing empirical research on informal sector economies offers several major challenges and difficulties. The lack of conceptual clarity and the presence of disciplinary functionalism have created considerable difficulties in formulating an appropriate methodological perspective from which to study the phenomenon (i.e. informal sector).” (Ferman, Stuart and Hoynman, 1987).
The research is primarily a literature study, which is restricted to descriptive research. As such, a hypothesis is not to be set in this research study. The reason for using this approach is that the research conducted on the informal market and its contributions to the economy is voluminous, yet it is scattered over many sources. It was felt it would be optimal to consolidate such research into one concise dissertation.
The information for the literature study has been obtained from:
Articles published on local and international Internet websites on the subject of the informal sector and its contribution to the South African economy.
Local and international articles on the subject published in tax and economic journals, and other business publications and newspapers.
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The table below provides a description of the research methodology that will be applied to address each research objective.
Table 1: Research objective methodology
Research Objective Research Methodology
Refer to 1.5.2 (i) The research objective will be achieved by performing a literature review to understand the nature of the informal sector as well as the operations that are carried out in this sector.
Refer to 1.5.2(ii) This research objective will be achieved by performing a critical conceptual analysis of the current tax-relief initiatives currently in place to identify and assess whether current tax legislation could accommodate the integration of the informal sector.
This chapter will also address any administration challenges identified and how they could be addressed.
Refer to 1.5.3(iii) This objective involves the study of the Tanzania Revenue Authority programmes that were implemented, in an attempt to put in place sustainable methods to grow their tax-revenue streams. This objective will be addressed through a literature review of the Tanzania processes. As there is no single source of information, the review will include review of newspaper articles, TRA publications, journals, articles and presentations on the processes implemented by the country. The process of identifying the challenges and putting in place the decision to implement the various programmes will also be discussed. Review on whether the programmes implemented were successful and sustainable will also be studied.
There is no single source of information, the review will include review of newspaper articles, TRA publications, journals, articles and presentations on the processes implemented by the country.
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1.7
CHAPTER DIVISIONThe following chapter layout is proposed for the research:
1.7.1. Chapter 1: Introduction and background
The objective of this chapter will be to present the research question and the research objectives that the study would like to achieve. In addition, it will provide a background to why the study has been selected and the research methodology to be applied in achieving the objectives.
1.7.2. Chapter 2: Informal sector, historical overview and literature review
Chapter 2 will aim to provide an understanding of the informal sector and how it operates.
The chapter will start with an overview of the history of the informal sector in South Africa and, through a literature review, the historical methods previously applied to taxing the informal sector.
A literature review in this chapter will provide more insight into the origins of the sector, the informal sector will be extensively defined, and distinguishing characteristics between informal and formal sectors will be identified.
Measuring the informal sector has been identified as a challenge for this dissertation; the role of this sector in the South African economy will be investigated with the aim of providing an idea of the magnitude and size of both the formal and informal sector. Statistics SA provides statistics into job creation by both the formal and informal sectors. Such information will be used to understand the contribution and impact of the informal sector on the South African economy, if any.
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The informal sector has for a long time been described as ‘difficult-to-tax’ because of the high levels of cash transactions, poor or no record keeping, and ignorance of laws and regulations. This chapter aims to analyse and identify these challenges.
This chapter will address the research objective as identified in par. 1.5.2(i).
1.7.3. Chapter 3: Tax relief initiatives applied in South Africa for small businesses
This chapter will consider the present tax initiatives, their objectives, and the practicality of applying this to informal sector entities in South Africa.
The study discusses the income tax-relief initiatives introduced in the South African tax law, the objectives and the practicality thereof. It considers whether these income tax-relief initiatives could be used as a tool to encourage a culture of compliance within the informal sector of the South African economy.
This chapter will address the research objective as identified in par. 1.5.2(ii). 1.7.4. Chapter 4: Tanzania Block Management System
This chapter will focus on the Tanzania Block Management System – the door-to-door survey. The TRA implemented the system with the objectives to promote and enhance voluntary compliance, and to detect taxpayers who are not paying taxes (or the correct amount of tax). Chapter four will perform an overview of the history of the BMS in the informal sector - the working definition, its measurement and size, the characteristics of and taxation of the informal sector in Tanzania.
This chapter will further evaluate the Tanzania Block Management System to establish if a similar system could be adapted in South Africa - and to possibly suggest an approach that may assist South Africa in being able to integrate the informal sector into the formal sector to contribute to national tax revenue.
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1.7.5. Chapter 5: Conclusions and recommendations
This chapter will provide a summary of findings, conclusions and the recommendations of the study.
The outcome of the study will aim to assess whether the current tax legislation can accommodate the integration of the informal sector into the formal sector. This assessment will discuss the factors accounting for the hard-to-tax nature of the informal sector (or informal trading).
It will further aim to provide recommendations on how, and if, the informal sector may be integrated and brought into the pool of existing taxpayers - with possible recommendations for improvements from the Tanzania Block Management System as discussed in chapter 4.
15 CHAPTER 2
2. INFORMAL SECTOR: HISTORICAL OVERVIEW AND LITERATURE REVIEW
2.1. INTRODUCTION
Many developing countries are dominated by small businesses that operate in the informal sector. Informal businesses have been known to make contributions to the economies of many developing countries through employment creation, the production of affordable goods and services in an attempt to alleviate poverty (Gikenye and Ocholla, 2014).
The aim of this chapter is to provide an in depth understanding of the informal sector, its characteristics and how it operates. The literature review on the informal sector will aim to define the informal sector and where it originates from. With the growth in the sector and its dualism nature in South Africa, this chapter will focus of the economic benefits that would be subject to taxation that arise as a result of the operations undertaken and will address the secondary research objective as identified in par. 1.5.2(i).
2.2. THE ORIGINS OF THE TERM ‘INFORMAL SECTOR’
Historically, the informal sector was viewed by many developing countries as a phenomenon that would disappear as modernisation spread through the economy (Marais and Ntema, 2014:127). Portes (as cited by Ingle, 2014), however, held that the sector would not disappear.
According to Ingle (2013a) there appears to be two different opinions as to the actual origin of the ‘informality’ concept.
The first dates back to 1942, to the scholarly identification of the sector when a Dutch anthropologist, J.H. Boeke, published Economies and economic policy in dual societies (Ingle, 2013a). Boeke considered a developing economy as a ‘dual’ economy, made up of the market economy part of the world and a part which lay outside.” This dual concept was taken up and elaborated on by Arthur Lewis in the 1950s and further by development economists Harris and Todaro in a “two-sector framework of equilibrium economics” in 1970 (Guha-Khasnobis, Kanbur and Ostrom, 2006).
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A second school of thought credits another British anthropologist, Keith Hart, with having originated the term’. Hart originated the term ‘informal economy’ in his 1973 paper “Informal income opportunities and urban employment in Ghana”, and it is believed that it was through his study that the term was introduced generally to development studies (Ingle, 2013a). Ingle (2013a) contests that Hart’s work led to an outpouring of research and policy focus.
Hart’s main insights were into the complexity of how livelihoods are shaped, the intertwining of the different types of activities, and the role of the state and bureaucracy in both developed and developing economies (Altman, 2007). Hart (1973) highlighted uncertainty of production activities, terms of employment, and income as a distinctive feature of informality (Blaauw, 2011). His central recommendation was for more empirical investigations to develop an understanding of these activities and how they interrelate. It is for this reason that the study will be based on the concept of informal sector as introduced by Hart in 1973.
2.3. INFORMAL SECTOR DEFINED
Based on the literature available on the informal sector, it is clear that no single definition exists for the informal sector (Ligthelm, 2004b). The sector is diverse and includes small scale, occasional members (such as street vendors and garbage recyclers) as well as larger, regular enterprises (World Bank, 2014).
The informal economy provides an important but poorly understood means by which many citizens in developing countries earn a living, and South Africans are no exception (Ingle, 2014). Although relatively moderate in size, the informal sector has a major role to play in reducing the incidence of extreme poverty (Van der Berg, 1990:38).
Due to globalization, formal employment has decreased everywhere in the world (Steyn, 2008). People cannot wait for governments to create jobs; they are creating jobs for themselves. Hence, the informal economy is growing quickly. The formal sector’s inability to
absorb growing populations has brought about an increase in the number of individuals hoping to secure an income through entrepreneurial self-employment. The informal sector has gained importance in many developing countries, including South Africa, hence the growth of the informal economy or sector.
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Ingle (2013a) is of the opinion that the informal sector is logically prior to the formal. The informal is the ‘natural’ default state of affairs out of which formality arises.
According to Antonites and Van Rooyen (2007) one approach to defining the informal sector is to define what it is not. The informal sector:
is not the formal sector (non-formal);
is not controlled by the government (non-plan, hidden, unofficial, unrecorded);
is not legal (illegal, black, shadow); and
is not taxable (unrecorded, parallel).
This definition is, flawed as it assumes that all activities of the informal sector are illegal and not taxable.
Blaauw (2011) sees the formal sector as a sector that is regulated and is affected by the direct and indirect taxation laws as well as other government regulations such as labour laws. It is located in markedly different industries from the formal economy. The informal economy is weighted towards trade-based economic activity. The formal economy is located more in service industries (Blaauw, 2011).
Chen (cited by Altman, 2007) outlined three approaches to explaining the informal sector, namely the dualist school, structuralist school and legalist school.
o The Dualist School: With development and rising per capita incomes, the informal sector would disappear. The entities were considered to be peripheral to capitalist production systems (Altman, 2007). A high prevalence of informal businesses was seen as a sign of underdevelopment. There has been almost no evidence that informal firms disappear. In 2016 the informal sector still exists, dominated by micro, small and medium firms (Altman, 2007).
o The Structuralist School, considers the informal sector as part of a continuum within the market, although located in a subordinate position. This approach would consider the interactions between the formal and informal sectors, whether in buyer-supplier relationships or in employment relationships such as contracting out or casualization. The informal sector contributes to the formal sector’s risk mitigation and cost-reduction
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strategies (Altman, 2007). Blaauw (2011) explained that the Structuralist School of thought is that the formal economy reduces labour and capital cost by subordinating small informal producers and traders. In this view the informal sector is not seen as a feature of a traditional sector, but instead a central feature of modern capitalist development (Altman, 2007).
o The Legalist School argues that the informal sector is comprised of entrepreneurs who want to avoid the costs and hassle associated with formalisation, particularly in relation to business and labour regulation and company tax (Altman, 2007).
The informal sector is often perceived as relaxed, casual, flexible and lacking in rules and regulations. For example, a business in the informal sector is considered to be an enterprise that does not follow the laws which control bigger formal businesses, such as the liability to pay taxes on income earnings.
Steyn (2008) is of the opinion that the fact that the informal sector is unregulated is not the same as the criminal or illegal economy. For many, non-compliance in this sector, is not to purposely avoid regulations and taxes. Ligthelm (2014) contends that some businesses operate partially or wholly outside the law by under-reporting (or not reporting) employment, avoiding taxes, infringing copyrights, and even failing to register as legal entities. Steyn (2008) agrees, by stating that while there might be entrepreneurs who deliberately try to avoid paying taxes, some entrepreneurs are often either not aware of the regulations or they cannot afford to comply with regulations.
Although certain activities in the informal sector derive from the desperation to secure much-needed means of household subsistence, the informal sector is not merely a set of survival positions occupied by destitute people on the margins of society (Horn, 2011). The informal economic processes cross-cut through the entire social structure (Horn, 2011). Informal economy enterprises include not only survival activities but also stable (steady) enterprises and dynamic growing businesses. All informal enterprises are affected by government economic policies (Steyn, 2008).
The World Bank (2014) found that the informal sector provides support to entrepreneurial activity and helps alleviate poverty. Ligthelm (2003) agrees that the motivational factor for starting a business is often unemployment. Steyn (2008) is of the opinion that the motivational factor shows that it is made up of non-standard wage workers and entrepreneurs who produce legal goods and services, even though the way they do it is not regulated.
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It has been a widely-acknowledged notion that the informal sector includes all unregistered and unrecorded economic activities that escape detection in the official estimates of the GDP (Ligthelm, 2004). The informal economy embraces all unreported income from the production of goods and services - both legal and illegal, either from monetary or barter transactions – hence all economic activities that would have been taxable if reported to tax authorities (Ligthelm, 2008). Mtshawulana (2008:2) stated that there is no guidance in the Income Tax Act with regard to the taxation of illegal activities, except to prohibit the deduction of expenditure incurred in paying fines or in relation to corrupt activities, as defined. For the purposes of this study the fraudulent activities of the economy are excluded, but might be captured in size estimates.
Informality is not limited to one economic sector, it emphasises the links between the informal and the formal parts of the economy (proper jobs with contracts and benefits according to the law) and it highlights the fact that more and more jobs and enterprises are informal (Steyn, 2008). Steyn (2008) infers that formal jobs are being ‘informalised’, plus more new jobs are being created in the informal economy at the same time. WCPER (2007) found that informal firms source their inputs and/or stock from formal sector businesses, however, very few are able to break into the market supplying larger formal enterprises.
Ligthelm (2014) and Gikenye and Ochalla (2014) are of the opinion that another motivation for informality in the modern economy is the burden of direct and indirect taxation and the burden of government regulations.
Gikenye and Ochalla (2014) also noted that even registered business enterprises are always beyond the pale of social protection, labour legislation and protective measures at the workplace.
According to the ILO (1993), the informal sector is defined as consisting of units engaged in the production of goods and services with the primary intention of generating employment and income to persons concerned. These units operate at low levels of organisation. Labour relations, where they exist, are based on casual employment, and personal and social relations, rather than contractual arrangement with formal guarantees (ILO, 1993).
The OECD distinguishes between the three unrecorded components of an economy, namely the underground, informal and illegal economies (OECD, 2002).
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o Underground economy is the component that consists of legal and productive activities that are deliberately concealed from public authorities in trying to avoid tax payments and having to meet government regulations such as minimum wages (OECD, 2002).
o Informal economic activities are those that are not conducted with the aim of avoiding any government regulations, and therefore legal. Production in this sector is normally undertaken in small households, with owner capital being used for unincorporated enterprises. According to LFS data, nine in ten informal workers reported earnings below the personal income tax threshold in 2001, therefore nullifying the argument that individuals turn to informal sector employment to escape paying tax (WCPER, 2007).
o The illegal economy, as defined by the OECD, embraces all forbidden activities and includes production and distribution of illegal goods (such as drugs), illegal services (such as prostitution), the production and sale of counterfeit products (such as false trademarks), smuggling (tobacco and weapons, for instance), resale of stolen goods, bribery and money laundering (OECD 2002). This part of the economy is referred to by others as the third economy.
The OECD (2002) provides a clear guideline on what the informality in the sector refers to. This study will focus on the defined informal economic activities to show that the informal sector comprises not only the illegal activities that come to mind, but legitimate operations that are undertaken in an environment where government regulations have not yet been implemented or are difficult to implement. In many cases, it may be the fact that it is not regulated that makes it attractive; however, the aim is not solely to escape compliance.
Marias and Ntema (2014) is of the opinion that the informal sector has the potential to drive economic growth and job creation in developing countries, and that it is important that this sector should be kept alive for the economic survival of developing countries in particular. With the continued substantial growth in the informal sector, it is plausible to argue that both overregulation and non-regulation of the informal sector seem to have failed to either completely eradicate (as initially envisaged by governments in developing countries) the sector and its perceived socio-economic ills, or to provide solutions to challenges facing the sector (Marais and Ntema, 2014).
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Based on the above, the linkages between the formal and informal sectors makes the two sectors co-exist and assist each other in economic development. This is mainly done through small businesses. WCPER (2007) found that small businesses are to be found in both the formal and informal sectors - and the small business sector can, therefore, not be discussed by contrasting it with the informal sector.
Government strategies are put in place in the belief that small businesses are more prevalent in the informal sector than they are in the formal (WCPER, 2007). This is the approach that will be applied to this study, as it aims to show some of the challenges faced by small businesses in the informal sector that make it difficult for them to operate competitively in the formal, regulated market. Small businesses have therefore been seen as a vehicle to create employment, promote economic growth and redistribute wealth; as such, the promotion of entrepreneurship has been identified as a critical aspect of Growth, Employment and Redistribution (GEAR) (Kambikambi, 2003).
Throughout this chapter, the reasons entrepreneurs engage in micro, small and medium business operations have been highlighted. These are: for survival purposes, where individuals simply want to be able to support themselves; or entrepreneurs seizing the opportunities created by gaps for demand of certain goods and services in the market (WCPER, 2007).
Other than the time and effort required for tax administration and the costly regulatory environment in South Africa, informal businesses face various other constraints, which are specific to the industry in which the business operates, and may vary according to business location, customer profile or product or services offered (WCPER, 2007).
A lack of access to business support services is an important constraint on the growth and development of small and informal businesses (WCPER, 2007). Therefore, there is a need for governments to prioritise intervention in and support for the informal sector through, inter alia, training and credit facilities and, most importantly, through the creation of an enabling regulatory environment (Marais and Ntema, 2014).
Several definitions have been considered to explain, categorise and designate the exact meaning of the informal sector (encompassing informal trade activities). This sector represents a spectrum of economic activities in commerce, agriculture, construction, manufacturing, and transportation and services, and epitomises approximately 60% of the
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labour force in urban areas of developing countries and subsequently supports the critical importance of defining the focus (Antonites and Van Rooyen, 2007).
The informal sector, by its nature, is necessarily difficult to observe, study, define, and measure. Antonites and Van Rooyen (2007) contends that “there is no single source that readily defines informal economy as a unit of study."
2.4. DISTINGUISHING CHARACTERISTICS OF THE INFORMAL SECTOR
Informality is considered to be unstable in that the activity operates outside of the bureaucratic rules or regulations (Altman, 2007). Many literature studies have been performed on the sector and many agree that the informal sector is characterised by the following characteristics: very small scale units producing and distributing goods and services (Gikenye and
Ocholla, 2014:31);
independent, self-employed producers in urban areas of developing countries (Gikenye and Ocholla, 2014:31);
businesses established to provide income and employment to family members, who often cannot find employment opportunities in the formal economy (Gikenye and Ocholla, 2014:31);
operate with very little, capital, owner provided capital (Gikenye and Ocholla, 2014:31);
operate at a low level of technology and skills (Gikenye and Ocholla, 2014:31);
provide very low and irregular incomes and highly unstable employment to those who work in it, with little protection by labour laws (Gikenye and Ocholla, 2014:31);
are unregistered and unrecorded in official statistics (Gikenye and Ocholla, 2014:31);
tend to have little or no access to organized markets, to credit institutions, to formal education and training institutions, or to many public services and amenities (Gikenye and Ocholla, 2014:31);
are not recognized, supported or regulated by the government (Gikenye and Ocholla, 2014:31);
individuals engaged in informal sector activity tend to be less educated and have fewer marketable skills than their formal sector counterparts (WCPER, 2007);
a large percentage of informal businesses are established in non-lucrative business environments (Ligthelm, 2004a);
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as far as legal identity is concerned, informal enterprises do not have corporate status (Ligthelm, 2004b);
do not maintain a complete set of accounting books (Ligthelm, 2004b);
enterprises are non-registered units in terms of taxation, labour or any other regulatory frameworks (Ligthelm, 2004b);
marked ease of entry (Antonites and Van Rooyen, 2007);
reliance on indigenous resources (Antonites and Van Rooyen,2007);
labour intensive and adaptive technology (Antonites and Van Rooyen,2007);
skills acquired outside of the formal sector (Antonites and Van Rooyen,2007); and
unregulated and competitive markets (Antonites and Van Rooyen, 2007).
Most workers and enterprises in the informal economy produce legal goods and services, although they are sometimes not in conformity with procedural requirements, such as registration or immigration formalities. These activities should be distinguished from criminal and illegal activities, such as the production and smuggling of illegal drugs, which are covered by criminal law and are not appropriate for regulation or protection under labour or commercial law (ILO, 2014).
Despite being viewed as a type of safety net, informal sector employment is inferior relative to that in the formal sector. It is made up of non-standard wage workers such as casual day labourers (Steyn, 2008). There is lack of compliance with labour, safety and minimum-wage legislation, combined with very little bargaining power on the part of informal sector workers, which means that they often have inferior employment conditions (WCPER, 2007).
Employment of workers in the informal sector is often on a temporary, casual or seasonal basis. They are less likely to have written employment contracts or paid leave, and are less likely to have their employers pay pension or retirement contributions or UIF deductions. This leaves informal sector workers vulnerable to exploitation while they work, and in a state of poverty once they no longer are able to work (WCPER, 2007).
The sector plays an important role in transition and developing countries in facilitating successful adjustment to globalisation and structural reforms.
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2.5. MEASURING THE SIZE OF THE INFORMAL SECTOR
Consensus is emerging on how to measure informality and activities within the informal sector, but only a few countries, including South Africa, produce regular statistics because market information systems are inadequate in many countries to estimate and monitor the informal economy (ILO, 2014).
The informal sector is notoriously difficult to quantify due to tax non-disclosure and the illegal nature of the activities in this economy (Muller, 2003). The informal sector is hard to tax due to the predominance of cash transactions, poor record keeping, high illiteracy rate, little or no barriers to entry, lack of laid down procedures, ignorance of tax laws (most the informal business owners are reluctant to declare income for the fear of being taxed) (Horn, 2011), and the rootless nature of some business activities and enterprises in the informal sector (Ofori, 2009).
Despite the various factors that cause the informal sector and its activities to be difficult to measure, various methods have been described in literature for measuring the size of the informal economy (Ligthelm, 2006). These methods can be broadly categorized into direct and indirect approaches. These methods are largely based on the work of Schneider (2002), conducted for the World Bank (OECD, 2002; Schneider and Klinglmair, 2005).
2.5.1. DIRECT METHODS
Direct methods are based on surveys and samples. The surveys may focus on various aspects such as household expenditure, informal business, and unemployment surveys (Ligthelm, 2006).
The advantages of direct methods include that experience has shown that they are considered fair and simple. Respondents are more willing to participate in the questionnaires, while the opposite is found for empirical research in the formal economy (Ligthelm, 2006). This method targets the informal sector directly, for example only targeting those active in the second economy. This method would also give insight into the characteristics, composition and dynamics of the informal sector.
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The disadvantages are linked to the flaws of survey research, which include among others the willingness of the respondent businesses to participate in the survey, average precision (due to this it is conceived that the survey method underestimates the size and can be regarded as providing conservative estimates) (Ligthelm, 2006) and the lack of sample frames and the micro-orientation of most the informal sector surveys.
Also, the overwhelming majority of individuals and businesses in the informal part of the first economy could not be identified, or simply refused to provide information or to provide correct information (Ligthelm, 2006). For this reason, direct measurement approaches such as surveys could not generate reliable information and indirect methods were being used more to address the gaps left by the survey methods of the direct method.
2.5.2. INDIRECT/INDICATOR METHODS
Indirect methods are macroeconomic in nature. They use various indicators that indirectly allow for the measurement of the size of the entire informal economy. Some of these methods are discussed below (Schneider, 2002; OECD, 2002; Loots and Saunders , 2005; Schneider and Klinglmair, 2002).
2.5.2.1. Discrepancy method
This method is aimed at establishing the discrepancy between GDP estimates from the expenditure and income sides (Loots and Saunders, 2005). Any residuals between these two variables are then ascribed to informal sector activities (Buehn and Schneider, 2013). In principle, the estimated size of an economy should be the same, whether calculated from the expenditure or income side. Thus, if the expenditure side exceeds the income side, the gap is indicative of the extent of the informal economy not captured on the income side. Schneider (2002:34) argues that the components of GDP are normally not measured without error, and the gap therefore reflects all omissions and errors made when compiling national account statistics. These estimates are therefore considered crude and their reliability debatable.
2.5.2.2. Labour discrepancy
The labour discrepancy method is based on a discrepancy between the so-called ‘official’ and ‘actual’ labour force - and may therefore reflect employment in the informal economy (Loots and Saunders, 2005). An officially recorded constant or declining labour force participation
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amidst a situation of declining unemployment may be regarded as an indication of an increase in the informal economy (Buehn and Schneider, 2013). This method is regarded as a weak indicator of the size and development of the informal economy, because labour force statistics are not always well developed, especially in developing countries (Ligthelm, 2006).
2.5.2.3. Transactions method
The transactions method was developed by Feidge (cited by Schneider and Klinglmair, 2005; OECD, 2002). It assumes that there is a constant relationship between the volume of transactions and GDP. Any change in that ratio is regarded as being caused by the informal economy. There are several problems with Feidge’s method. The method makes use of an assumption of a based year (where there is no informal activity in that year) and the assumption of the so-called ‘normal’ ratio of transactions over time. The model also requires precise figures of the total volume of transactions to allow a reliable estimation of the informal sector. These may not be available, especially for cash transactions (Buehn and Schneider, 2013).
2.5.2.4. Global indicator method
An example of the global indicator method is the electricity consumption approach in which it is assumed that electric-power consumption is the best single physical indicator of GDP growth. It assumes a precise and stable relationship between electricity consumption and output. A change in this ratio is assumed to be caused by informal economy activity. This method is simple and an easily applied calculation, but it does not take into account that certain informal economic activities such as street vendor and tuck shops require limited or no electricity, and that alternative energy sources (such as gas and coal) can also be used, and that technological progress and energy savings may also impact on the GDP/electricity elasticity over time (Ligthelm, 2006; Buehn and Schneider, 2013).
2.5.2.5. Currency demand method
This method states that the informal transactions are undertaken in the form of cash payments (Loots and Saunders, 2005) . It is therefore assumed that the size of the informal economy will therefore increase the demand for currency. This approach does not take into account the fact that not all the transactions in the informal economy are settled in cash (Loots and
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Saunders, 2005). It makes no distinction between informal activity in the second economy and informality in the first or modern economy. It also assumes that the tax burden is the only factor contributing to the informal economy, which is not the case (Buehn and Schneider, 2013). Furthermore, this method would also measure the transactions emanating from fraudulent or illegal activities, which also give rise to cash transactions to avoid any traces of such activities (Ligthelm, 2006).
2.5.2.6. Cash to deposit ratio method
The cash to deposit ratio method is based on the ratio between cash and transferable money. It is argued that the way in which people make payments is affected only by changes in taxation and government regulations, in an attempt to conceal certain activities to avoid taxation. It is these hidden activities that are used to estimate the size of the informal economy. This method can be criticised based on its underlying assumptions. These include the fairly stable cash-to-deposit ratio of the observed economy; that the ‘surplus’ money held in cash is only in the hidden economy; and that one dollar held in cash is only in the hidden economy; and that one dollar held in cash in the informal economy generated as much value added as one dollar in the formal economy (Ligthelm, 2006).
2.5.2.7. Latent variable methods
The macro-modelling methods described in these previous sections assume that the informal economy can be modelled in terms of one, or a small number, of variables. The latent variable method combines a wide range of explanatory variables, including the tax burden, unemployment rate, tax morality and per capita income that may impact on the size of the informal economy. This method can also be questioned, due to its high demand for data that is often not available and/ or unreliable.
All the macro-modelling methods tend to produce high estimates (OECD, 2002:187). The discrepancies that may emanate from these various approaches should be considered when evaluating informal sector measurement studies. It is evident with the different methods above that there seems to be certainty that the informal economy can never be precisely measured (Van der Berg, 1990).
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The individual transactions with the informal economy may be small; however, collectively these represent significant buying power (Beneke, Curran, Forsyth and Lamb, 2011). The actual size of the informal economy in the South African context remains a question still to be answered (Ingle, 2014).
2.6. THE ROLE OF THE INFORMAL SECTOR IN SOUTH AFRICA
Many studies performed on the informal sector concur that developing countries are dominated by informal sector enterprises that make a major contribution to creating employment, and that they exist primarily due to the inability of the formal economy to provide employment opportunities to a rapidly expanding labour force (Gikenye and Ocholla, 2014). Its emergence is largely attributed to the divergence between the growth in the urban population and employment growth in the formal economy. The shortage of productive employment opportunities in the formal sector, therefore, compels people to fend for themselves. In South Africa, that is how the informal sector constitutes an important part of the economy (Gikenye and Ocholla, 2014).
The informal sector has gained prominence in South Africa, it is seen as an alternative to the formal sector opportunities and has been portrayed as a solution to the generation of income for the many unemployed South Africans (Horn, 2011). In 2002 to 2003, the informal retail business sector was found to have contributed an estimated 28,4 per cent of South Africa’s GDP.
A study by Ligthelm in 2005 indicated that the growth of the informal economy in South Africa was eight times that of the formal economy between 2001 and 2006 (Ntema and Marais, 2014). This shows the prominence of the informal sector in South Africa.
The informal sector has attracted considerable research during the past two to three decades, not only because of its sheer size but also because of its potential role in providing income-generating and employment opportunities, particularly for the unemployed in South Africa (Ligthelm, 2006).
Former president Thabo Mbeki, coined the term “second economy” during his term as president. This term has since been used to classify the elements of economic productivity which fall outside the country’s official recorded Gross Domestic Product (Beneke, et al., 2011). In essence, the terms, ‘second economy’ and ‘informal sector’ have become
